What is liquidation?
The liquidation of a company is the process by which a company winds down and ceases to exist. This can arise for many reasons and can be voluntary or involuntary. The process involves the appointment of a liquidator, gathering of company assets, paying off creditors, settling of affairs and distribution of remaining funds to shareholders.
Benefits of liquidation
Whilst companies can be forced into liquidation in cases of insolvency, there are practical benefits from liquidating a solvent, healthy company. These range from large tax benefits (in certain circumstances), to the reduction of ongoing compliance costs and the ability to distribute assets “in specie” (their current form).
TAX CONSIDERATIONS IN LIQUIDATION
Taxation issues may arise during the process of liquidating a company in a number of circumstances. The sale of transfer of a company asset may result in a taxable gain. In such a case the liquidator will need to pay the relevant income tax prior to distributing any remaining cash or assets to creditors or shareholders.
When distributing company assets in specie, a liquidator will need to consider:
• GST treatment;
• CGT implication, including the deemed market value; and
• The timing of tax payments and liabilities to ensure dividends are franked to the maximum extent possible.
Failing to take into account these factors can result in a liquidator becoming liable for tax debts incurred after their appointment.
Taxation issues may also arise in relation to distributions made to shareholders. Under section 47 of the Income Tax Assessment Act, a distribution is deemed to be a dividend to the extent it comes from the following “income” sources:
• Ordinary income;
• Statutory income; or
• Assessable capital gains.
To be able to determine the extent to which a distribution will constitute a deemed dividend, so that the necessary tax can be paid, it is crucial that a liquidator is able to determine the composition of the distribution. This is known as the Archer Brothers Principle.
Archer Brothers Principle
“By a proper system of bookkeeping the liquidator, in the same way as the accountant of a private company which is a going concern, could so keep his accounts that distributions could be made wholly and exclusively out of those particular profits or income.” – Archer Bros Pty Ltd (In Vol Liq) v. FCT (1952-53) 90 CLR 140
This principle requires liquidators to maintain records and preferably separate accounts so that the specific source of funds used to make distributions can be identified and thus taxed appropriately. This principle is also a useful guide for any ongoing company, as consistently maintaining such separation and records of both Capital and Revenue reserves will make the process of liquidation in the future far easier.
Whilst returns to shareholders can be considerable, there may be tax requirements depending on the nature of the distribution. Based on the composition of the distribution, it may be deemed in part or wholly as a dividend which will incur tax.
Shareholders who acquired their shares before 20th September 1985 can potentially receive considerable tax-free capital gains upon liquidation of a company. However, pre-CGT shareholders are still assessable on the dividend component of a liquidator’s distribution.
Upon the cancellation of shares in a company at the completion of liquidation a capital gain or loss may occur, known as a CGT event C2. Any assessable dividend distributed by a liquidator will still form part of the proceeds for the share cancellation and can therefore reduce any capital loss. The timing of dividends can impact the availability of capital losses for the shareholder depending on whether they were before or after the appointment of the liquidator.
Small business GST
The small business CGT concessions can drastically reduce the tax liability on sale of business assets for qualifying taxpayers and can be used to reduce the tax liability of shareholders upon liquidation. Shares in a company can potentially be an active asset if the company has previously conducted a business and several conditions are met, including:
• $6 million net asset value; or
• $2 million turn over test.
• Typically, the shares must have been an active asset for at least 7 years or half the ownership period.
Where all conditions are satisfied, a capital gain on cancellation may be reduced using small business CGT concession. A general discount of 50% on taxable capital gains applies and can be further reduced by 50% in some scenarios. Additionally, up to $500,000 of the remaining taxable capital gain can be taken as tax-free retirement benefit (if you are under 55 this must be paid into a superannuation fund).
CONCLUSIONIf you have any queries about tax strategies in company liquidation, please contact Mr Stipe Vuleta of our Insolvency & Reconstruction Team on (02) 6188 3600.
Voluntarily liquidation of a company presents many great benefits to shareholders, however care needs to be taken both during and prior to liquidation to ensure that funds can be correctly identified and tax appropriately. Distributions made to shareholders also may be taxed differently depending on the nature of their shares.